Analysis and criticism of America's most prominent public intellectual and champion of Keynesian economics. I am part of the Austrian School of Economics, and I critique Krugman's writings from that perspective.

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Friday, October 14, 2011

Rabbit holes and rabbits from the hat

I find it ironic that given this blog deals with Paul Krugman's residence in Economic Wonderland, The Great One himself has referred to the "rabbit hole" of Wonderland in his latest bout of Wisdom From On High (or at least from Princeton). As I read Krugman's current attempt to rewrite history, I find that he pretty much is sticking to the same fanciful script and calling it economics. In other words, while claiming others are living in Wonderland, Krugman actually is writing about himself.

Before going on, however, let me say how grateful I am to Krugman for his willingness to sit through yet another Republican presidential debate and to be our eyes and ears. Some of us unfortunates who either cannot find an available TV or who are too busy looking after our families to watch thank him for his important contribution to the civil and political fabric of our nation. Thanks, Paul!

Of course, because I have not watched the debates, I have been unable to catch the latest on 9-9-9 (which makes me think of the song from the Beatles' white album in which we hear over and over again, "Number nine, number nine, number nine"....) or Ponzi schemes or the name of Rick Perry's hunting club. You know, the important things.

However, I have my doubts that even the Republicans are blaming Barney Frank for this entire mess, although he did play an important role by shilling for Fannie and Freddie and helping to keep them alive in the days when they were leveraged about 75 to one. In other words, if they wanted to put some of the blame on Steven Gobi's good friend, I would not object.

However, it seems that Krugman really wants us to believe that the ENTIRE crisis was simply generated by the failure of unregulated private enterprise and that government did only good. You think I exaggerate? Read on:

In the real world, recent events were a devastating refutation of the free-market orthodoxy that has ruled American politics these past three decades. Above all, the long crusade against financial regulation, the successful effort to unravel the prudential rules established after the Great Depression on the grounds that they were unnecessary, ended up demonstrating — at immense cost to the nation — that those rules were necessary, after all.

But down the rabbit hole, none of that happened. We didn’t find ourselves in a crisis because of runaway private lenders like Countrywide Financial. We didn’t find ourselves in a crisis because Wall Street pretended that slicing, dicing and rearranging bad loans could somehow create AAA assets — and private rating agencies played along. We didn’t find ourselves in a crisis because “shadow banks” like Lehman Brothers exploited gaps in financial regulation to create bank-type threats to the financial system without being subject to bank-type limits on risk-taking.

Yes, you see that the financial deregulation that began in the late 1970s and was strongly bolstered by DIDMCA in 1980 was the product of Republican rule and ideology. (And Krugman has written that many times, folks, like it or not.)

Whoops! Democrats had the presidency AND overwhelming majorities in the House and Senate during those years. Being that Ted Kennedy was a major architect of deregulation, I had no idea the guy was a closet Republican, but there it is. Krugman has a Nobel, so he ought to know. (Notice that Krugman never even tries to look at what was happening during that time, events that sparked the deregulation movement. Instead, he rewrites history and attacks anyone who might challenge his false claims.)

Furthermore, let us look at why this housing bubble came about. In Krugman's Wonderland, banks just all of a sudden started going wild with mortgage lending about 20 years after some of the handcuffs had been taken off. There is no causality, nothing other than some of the regulations had been removed two decades before.

In Krugman's Wonderland, there are no government programs to promote home ownership, and the Federal Reserve System played absolutely no role at all in helping to provide the massive amount of funds that went into this bubble. There was no Community Reinvestment Act and no directives from the federal government that lenders target people with bad credit scores or no savings and tailor loans to fit their situations. Furthermore, there was no encouragement from Alan Greenspan's and Ben Bernanke's Fed to lenders that if they got into a pinch, that Uncle Sugar would provide the "liquidity" to get them through the crisis. No, none of that.

Wonderland Economics, you see, has no cause-and-effect. The government changes some of the rules for banking and -- Voila! -- years later, all of the lending institutions suddenly run off the cliff like a pack of lemmings. There is no reason, nothing. It just happens.

But, Krugman has yet another howler up his sleeve:

The demonization of Mr. Frank aside, it’s now obviously orthodoxy on the Republican side that government caused the whole problem. So what you need to know is that this orthodoxy has hardened even as the supposed evidence for government as a major villain in the crisis has been discredited. The fact is that government rules didn’t force banks to make bad loans, and that government-sponsored lenders, while they behaved badly in many ways, accounted for few of the truly high-risk loans that fueled the housing bubble.

I spoke to some real estate lawyers during the aftermath of the collapsing bubble, and they told me that both federal AND state government officials were pressuring lenders to reduce their underwriting standards, something that Krugman knows, but cleverly denies. To add to the government's role, Veronique de Rugy points out:

The federal government’s role in the housing market goes back at least to 1938, but that role changed fundamentally in the 1990s when the government made a push to increase homeownership in the United States. At that time, the federal government pursued several policies that were meant to encourage banks to lend money to lower income earners and to give incentives to low income earners to buy houses. The result, as we now know, was a gigantic amount of subprime mortgages at a time when house prices were starting to go down.

Does Wall Street deserve some of the blame? Absolutely. It was concentrating on the profit that could be made and ignoring risk. Mortgage underwriters, investment banks, rating agencies, and investors all made this mistake. Of course, the GSEs did the same thing. And remember, they also got the party started to begin with. It was their incredible performance from 2001-2003 that made banks take notice.

So were the GSEs the only cause of the housing bubble? Of course not. But it doesn't make any sense to say that they weren't a central cause or didn't play a major role. If you look at their enormous quantity of originations over the past decade, their presence is undeniable. And if you look at the losses they've sustained since then -- which have led to a $148 billion bailout so far -- it's hard to keep a straight face and say they paid enough attention to risk.

I would agree wholeheartedly with both de Rugy and Indiviglio. The banks and financial houses were irresponsible (that is a most mild term, as I cannot think of one that actually fits their conduct this early in the morning), but the fuel for their fires came in large part from government-sponsored entities.

Krugman wants us to believe that Wall Street entities all of a sudden came up with the idea of throwing huge amounts of resources into an unsustainable housing bubble. It just happened; there was no causality, nothing.

But Krugman is not done. No, while he writes of "rabbit holes," he also is promoting the economics of "pulling rabbits from hats." Yes, President Obama can turn things around with his latest "jobs bill" or the Fed can push "aggregate demand" through Operation Twist, and the beat goes on.

Krugman wants us to believe that government can subsidize us into recovery through "green jobs" while cutting out nearly 10 percent of the current electricity grid through environmental regulations. He wants us to believe that government can discourage capital formation through taxes and regulation and then claim it doesn't matter since there is "unused capacity" out there, so capital formation isn't necessary.

Perhaps I am a romantic, but I have this quaint idea that decorated academic economists should not act as shills for a particular candidate or political party. Furthermore, I have this quaint notion that economists really should be looking at cause-and-effect, as opposed to making political claims of good and evil, and then saying government is good (when the Democrats are running it) and private enterprise is evil (because profits are evil).

So if Krugman does happen to be correct that most of the 'truly high-risk loans that fueled the housing bubble' were NOT government-sponsored leanders, he is still wrong on point because of all the non government-sponsored lenders being forced to create similar products to maintain competitiveness, hoping to still have a seat when the music stops.

In this regard, the government lead, and private industry followed...right off the cliff -- but it's private banks' fault because they have more money invested.

Correct. According to Krugman, all of the government programs were based upon sound finance and compassion, but by seeing an opportunity for profit, the banks corrupted everything. So, it is their fault.

"Yes, you see that the financial deregulation that began in the late 1970s and was strongly bolstered by DIDMCA in 1980 was the product of Republican rule and ideology. (And Krugman has written that many times, folks, like it or not.)"

And looking at DIDMCA in wiki we find the first item on the list is 'It forced all banks to abide by the Fed's rules'.

"The fact is that government rules didn’t force banks to make bad loans, and that government-sponsored lenders, while they behaved badly in many ways, accounted for few of the truly high-risk loans that fueled the housing bubble."

When I was getting my home loan in the beginning of 2007 I was told that if you can get a fannie \ freddy mac approval then you are basically going to be approved for the loan from the lender (or any lender for that matter) I was working with.

I also want to mention that when I was a bank teller back in 1995 they were constantly harping on us to make sure we knew about the Community Reinvestment Act (CRA) because the bank had 'secret shoppers' that would be asking about it. If we didn't reply what they wanted to hear there would be some sort of penalty (but I don't know what).

"In Krugman's Wonderland, there are no government programs to promote home ownership, and the Federal Reserve System played absolutely no role at all in helping to provide the massive amount of funds that went into this bubble."

Plenty of countries had housing bubbles without any CRA legislation. That loose Fed policy and faulty government policy played a role is not in doubt, but doesn't change the fact that a highly ineffective regulatory environment was to blame was mainly to blame.

In fact, history just ran an experiment for us. The US allowed itself to have a flawed system of financial regulation, while Canada maintained an relatively efficient one run on the principle of preventing reckless lending and securitization by banks. The result:

In 2008, the World Economic Forum ranked Canada’s banking system as the soundest in the world. The U.S. system was ranked at number 40 and Germany and Britain ranked 39 and 44. Canada’s banks have required no bailouts to save financial institutions.

Canada’s banks were restricted by regulators from mass securitizing of mortgage debt. Canada’s banks also were prohibited from taking on high levels of leverage to make larger and riskier loans. The Canadian mortgage industry was regulated to maintain high lending standards, instead of lax ones allowing an explosion in sub-prime mortgages.

Like most Austrians, you are clueless about what goes on in the rest of the world.

Imagine an omniscient and benevolent elf named Ralph. If we only elected Ralph the Elf to regulate and be the overseer of every single economic decision and transaction in the whole wide world, nothing would ever go wrong. You crazy Austrians don’t ever want things to be nice and just right. Do you really hate mankind?

Please correct me if I am wrong... but it seems to me that both Keynes and Krugman had/have no skin in the game ... i.e., they were/are childless. Not having children to dote on leaves one with plenty of time to dote on ones self... to live in the 'now' the future be damned.

Imagine an omniscient and benevolent elf named Ralph. If we only elected Ralph the Elf to regulate and be the overseer of every single economic decision and transaction in the whole wide world, nothing would ever go wrong. You crazy Austrians don’t ever want things to be nice and just right. Do you really hate mankind?

For every capitalist banker in the world there must be at least one Elizabeth Warren looking over his shoulder making sure he does the right thing before they are approved. Washington DC hired only a few million Elizabeth Warrens to oversee the filthy rich and you see what that got us. One for one, or we are done.

About Me

I teach economics at Frostburg State University in Frostburg, Maryland. We are located on the Allegheny Plateau, and we have cool summers and tough winters.
I am the single father of five children, four of them adopted from overseas and I have two grandchildren. My family and I are members of Faith Presbyterian Church (PCA).